External Account Troubles

As Pakistan braces for the economic fallout of the COVID-19 pandemic, it must not lose sight of how it could be affected by a global recession, writes Saad Rajput

External Account Troubles
As if straight out of a sci-fi novel, the pandemic of our times is here. Covid19 continues to engulf human life, having affected two million people in 210 countries and territories so far, and killing over 100,000. Entire cities have been locked down as governments around the world enforce strict social distancing measures to contain the impact of an invisible enemy. Life as we know has come to a complete standstill.

Amid an exponentially rising death toll is also the very real threat of a global economic recession, the likes of which the global economy has never seen before. Already, the economic slowdown in some of the richest economies of the world has caused unprecedented damage: in the US and Europe, for example, one of the leading indicators for GDP – the Purchasing Manager’s Index – has dipped more than it did during the financial crisis of 2008-09. In China too, any hopes of a quick recovery are being dampened as the possibility of new outbreaks cannot be ruled out.

For an economy like Pakistan’s, which was going through a recovery after a balance of payments crisis in early 2019, the spill over effects of a global recession could be very serious. While expanding social sector spending and monetary easing may help mitigate the effects of a fall in domestic demand, the interconnected superstructure of the global economy would pose a totally separate set of risks to the health of the economy in the foreseeable future.

A major issue here is that of the foreign debt that Pakistan holds, which includes borrowings from bilateral and multilateral creditors. The country’s total public external debt stands at about $85 billion, of which long term debt is valued at $68 billion, short term at $2.8 billion, the IMF Extended Fund Facility (EFF) at $6 billion, and central bank deposits and foreign currency bonds together at $10 billion. For the IMF facility alone, Pakistan is scheduled to repay $850 million in 2020, and amounts of a billion each year from 2021 to 2024.

The country’s foreign exchange reserves, after consistently increasing each week since October 2019, dipped for the first time in the week ending March 13, and have been falling ever since. Currently, the State Bank of Pakistan’s (SBP) reserves hold about $10 billion, with banks holding an additional $6 billion. Pressure on reserves in the past month came mainly from panic around emerging markets, as investors dumped government bonds and other debt instruments for safer, more liquid assets. Foreign exchange reserves in emerging markets continued to decline as central banks scrambled to keep local currencies stable. Fears of how the pandemic may impact developing economies such as Pakistan, coupled with a policy rate decrease of two percent announced by the SBP, led to a total of about $1.5 billion leaving Pakistani treasury bills and PIBs in March alone.

There may still be some respite in the coming days. Following negotiations to be held this week, another US$1.4 billion may be released by the IMF this month as a Rapid Financing Instrument (RFI). In addition to the RFI, existing packages of $1.25 billion from the ADB and another $1 billion from the World Bank may be redirected towards covid19 related assistance. Pakistan may therefore be able to weather the immediate storm and pacify a liquidity crunch in the short term. The challenge, however, will be to address external account imbalances, especially those emanating from the current account, once it is time to repay these financial facilities as the COVID19 outbreak settles.

Since the PKR devaluation in 2019, Pakistan’s trade deficit had been shrinking considerably before the COVID19 outbreak began in March. Total exports rose by over three percent to $15.6 billion in the first eight months of the current fiscal year. Imports during this period dropped by 14 percent, resulting in a trade deficit of $15.7 billion, down by over 25 percent. But now, as demand in economies across the world stagnates with the spread of the virus, Pakistan’s exporters will see significantly fewer orders for their products from buyers abroad, for at least the next few months. Projections by the World Trade Organization (WTO) show that world trade could contract by 13 percent in an ‘optimistic scenario’, and by a third of its value in a ‘pessimistic scenario.’

Dwindling exports will be accompanied by a drop in the import bill, as demand at home falls as a result of lockdowns in major cities. There will also be some relief from the recent fall in global crude oil prices. Crude fell earlier this year as a result of failing negotiations between major oil producing nations – mainly Saudi Arabia and Russia – to curtail the supply glut. With negotiations now moving in the right direction, however, a free fall in the price of crude may be avoided. But the fact that global demand for crude has fallen by almost a third means that the price of a barrel of oil should remain under $40 till a global recovery starts.

Workers’ remittances could also see a dip, given lockdowns in most cities abroad. About 85 percent of Pakistan’s remittances come from the UAE, Saudi Arabia, UK, USA and other GCC countries. For the month of March 2020, remittances rose by 3.8 percent to $1.8 billion compared to March of last year. However, these may fall considerably in the coming months as the true brunt of an economic slowdown is felt across the globe. The month of Ramazan, during which remittances spike every year, may still provide significant remittance inflows.

So far, the government’s economic team has responded admirably by announcing a stimulus package worth Rs1.25 trillion, partly made up of fiscal measures such as tax breaks and concessions to the industry. This package also includes the largest social protection effort in the country’s history worth nearly $1 billion and targeting over 12 million households across the country. Additionally, SBP has introduced a refinance facility to incentivize businesses not to lay off workers.

However, in dealing with the global economy, a more structured approach should be adopted. Inspiration could be drawn from the example of the African Union (AU), which has constituted an envoy team to solicit international support to help the continent deal with the economic impact of the COVID19 pandemic. Solely personalized attempts at economic diplomacy seldom work, which is why the Prime Minister’s well-intentioned appeal at donors for restructuring foreign debt needs to be followed by a concerted effort on the economic diplomacy front. Existing partnerships need to be strengthened, and new ones based on evolving principles of the global economy must to be forged. Once the storm settles, who knows how much would have changed?

The writer is an economist